As monetary policy runs out of steam, will new Chancellor decide to borrow to fund infrastructure asks leading fund manager

13th July 2016

The new Chancellor of the Exchequer Philip Hammond may have to face up to the fact that the limits of monetary policy have been reached and he may have to consider a fiscal boost for the economy says a leading fund manager.

Richard Buxton, head of UK equities and CEO, Old Mutual Global Investors says: “Philip Hammond walks into one of the most unusual economic environments I have known in my 30-year investment career. The monetary policy experiment we’ve witnessed since the financial crisis has probably reached its limits, while the pro-‘Brexit’ vote means we’re facing an economy that may grind to a halt over the next few months, not through a traditional credit boom being reined in by the central bank, but simply in response to the referendum result. The question the new chancellor will have to ask himself is: is further monetary stimulus really enough, or is it time for the baton to be passed on to fiscal policy?”

Buxton says that the Treasury can take a number of measures to boost the economy such as reducing stamp or petrol duty, however he suggests that a decision may be made to borrow to boost infrastructure.

He adds: “The Treasury can take a number of measures to help boost the economy, such as reducing stamp duty or cutting tax on petrol. However, I believe that we might eventually see more extreme fiscal stimulus: debt issuance to help back private sector or government schemes for infrastructure projects. Such fiscal stimulus is being planned in Japan in recognition that monetary stimulus alone is insufficient. Ideally, any such move amongst the major economies would be co-ordinated, but if Japan has led the way, it is perfectly possible to see the UK and the US following suit.

There are downsides. He says: “The major drawback of loosening fiscal policy independently of other major economies is that a rising budget deficit could see foreign investors requiring a cheaper currency to attract their investment – potentially yet further weakness in sterling.

“The Bank of England has acknowledged the limits to further monetary stimulus, but equally cautioned that the Government must remain fiscally prudent and responsible. Against the ‘protest vote’ referendum result, however, the chancellor has to find the right balance between stimulating the economy, managing debt and pleasing the crowd by reducing income inequality.

“That is an enormous challenge. History suggests that in modern democracies the temptation to inflate your way out of trouble through stimulus and debt devaluation ultimately prove irresistible. The next few months are undoubtedly going to be interesting and we will be looking to take advantage of the opportunities as they present themselves. ”